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Jesper Madsen runs a China fund, but you'll rarely hear him talk up that nation's superfast growth rate, its potential to overtake the U.S. as the world's largest economy, or any other clichés popular among investors. Instead, the lead manager of the $107 million
Matthews China Dividend
fund (ticker: MCDFX) uses phrases like "shareholder participation," "cash flow," and "corporate governance."

Yet Matthews China Dividend is no stodgy income fund. While it might appeal to income seekers—it has a dividend yield of 3.6%—Madsen's portfolio is full of smaller, faster-growing companies that tap into China's consumers. More than 60% of the fund's portfolio is in stocks with a market value of $5 billion or less, compared with the 11% allocation to stocks that size in the MSCI China Index. Madsen looks at the dividend not just in terms of income but also for what it tells him about the company.

That focus has served Madsen's investors well. The fund has returned nearly 11% annually since its inception in November 2009, far better than the MSCI China Index's 0.6% loss. And during the past three years, it has returned 9.9% annually, putting it at the top of the China-fund class for that period. This year, it's in the top 5% of China funds.

Denmark native Madsen and his co-manager, Yu Zhang, born and raised in China, look for companies that have reasonable valuations, treat investors well, and have the potential to raise dividends. That means avoiding some of the large state-owned enterprises, on the one hand, and missing out on some of the faster-growing companies in China, on the other, but it still leaves room for big gains.

"We might not be as aggressive," says Madsen, 37. "But dividends give you a higher degree of certainty."

While receiving his B.A. in politics, philosophy, and economics from the United Kingdom's University of York, Madsen became intrigued by the fact that some Asian nations had thrived despite lacking the natural resources of Africa and Latin America. After graduation in 1999, he headed to China's Guangdong province to teach English and then spent seven months backpacking through Asia. In 2007, Madsen backpacked through China again, even though this time he could have afforded much loftier accommodations. "Sitting there in the rain and just chatting with people, you get a much better feel for what's happening," he says.

That on-the-ground approach helps to screen out the noise when stock-picking. "When I look at Chinese companies, it's not like the rules are different," he says. "It all boils down to simple truths about how people act toward incentives."

The incentives, however, can be quite different—and that's what makes the dividend so important. In China, many companies are majority-owned either by the state or their founders, which can put their interests out of sync with those of minority investors. And since there are fewer rules in place to protect investors, the difference between a winning bet and a losing one can come down to making sure everyone's on the same page.

"As a minority shareholder, it's important to see checks and balances," Madsen says. "The dividend is one" of them.

For instance: A company whose founders need the cash generated by a payout is more likely to maintain the dividend. And that fact helps Madsen and Zhang feel comfortable with
Haitian International Holdings1882.hk 2.816901408450704%Haitian International Holdings Ltd.Hong KongHKD16.06
0.442.816901408450704%
/Date(1438376464000-0500)/
Volume (Delayed 15m)
:
1336000
P/E Ratio
N/AMarket Cap
25631759147.644
Dividend Yield
2.2415940224159403% Rev. per Employee
1865650More quote details and news »1882.hkinYour ValueYour ChangeShort position
(1882.Hong Kong), their top holding. Haitian's founder and his family own about 60% of the shares, Zhang says, and a consistent dividend—it has a yield of 2.2%—means quite a bit for their income. The company, which built itself up from supplying local companies to having a global footprint, has gained 30% this year, in part because it "weathered the downturn [in China last year] better than the peers," Zhang says, adding that it remains a core holding.

DON'T EXPECT TO FIND many banks in the portfolio, despite their hefty dividend payments. Madsen has just 17% of the fund invested in financials—well below the benchmark's 40%. "It's very tough for us, given the uncertainties of the financial system, to predict the dividend growth of a Chinese bank over the next three years."

Thanks to worries about a bubble brewing in China's real-estate sector, the fund has shied away from most residential property stocks. They have, however, bought into commercial real estate. One example:
CapitaRetail China Trustau8u.sg -2.1538461538461537%CapitaLand Retail China TrustSingapore: SGXSGD1.59
-0.035-2.1538461538461537%
/Date(1438380258000-0500)/
Volume (Delayed 20m)
:
1846400
P/E Ratio
10.772357723577235Market Cap
1335667403.52358
Dividend Yield
1.6729559748427674% Rev. per Employee
N/AMore quote details and news »au8u.sginYour ValueYour ChangeShort position
(CRCT.Singapore), a real-estate investment trust based in Singapore that owns and operates shopping malls in China. The company, which the fund has owned since its inception, has a dividend yield of 5.3%, and has gained 10% so far this year. "The management has been on the ground for many years," Madsen says. "And they've been through the jitters you expect from time to time."

The fund is also light on technology stocks, with just 2.6% of the portfolio devoted to the fast-growing sector. The reason: Only a few pay a dividend.
Baidu BIDU -1.0374276379893392%Baidu Inc. ADRU.S.: NasdaqUSD172.66
-1.81-1.0374276379893392%
/Date(1438376400110-0500)/
Volume (Delayed 15m)
:
4139923AFTER HOURSUSD172.11
-0.55-0.318545117572107%
Volume (Delayed 15m)
:
40878
P/E Ratio
28.733088149639713Market Cap
60690934833.0861
Dividend Yield
N/ARev. per Employee
198163More quote details and news »BIDUinYour ValueYour ChangeShort position
(BIDU), for instance, has the free-cash flow to pay one—but it, along with most others, refuses to return cash to investors because they fear it would signal the end of their growth, Madsen says. They do own
Taiwan Semiconductor
(TSM), which pays a 2.9% dividend to investors. In the past, the company tried to change Taiwanese regulations to allow it to pay a consistent dividend, even when the earnings aren't there when it comes time to pay.

The fund's bread and butter remains in consumer stocks, which make up 37% of the portfolio. One of their favorites:
Johnson Health Tech1736.Tw -1.721664275466284%Johnson Health Tech Co. Ltd.TaiwanTWD68.5
-1.2-1.721664275466284%
/Date(1438372158000-0500)/
Volume (Delayed 20m)
:
274575
P/E Ratio
9.025032938076416Market Cap
20715583765.625
Dividend Yield
2.9197080291970803% Rev. per Employee
N/AMore quote details and news »1736.TwinYour ValueYour ChangeShort position
(1736.Taiwan). The company manufactures fitness equipment, and it's slowly transforming itself from a low-end producer geared to selling directly to consumers into one that can target health clubs. The company's earnings grew by 11% in 2012 and its dividend, now 2.5%, should continue to grow along with the company's profits.

"It's a company that paid next to nothing," Madsen says. "But we're not going to get hung up on low dividend yields today if management is committed to growing it."